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A succession of conversations with record labels over the last couple of months has made me start to ponder whether we are approaching a tipping point in streaming era A&R. At the heart of the conversations is whether the growing role of playlists and the increased use of streaming analytics is making label A&R strategy proactive or reactive? Is what people are listening to shaped by the labels or the streaming service? To subvert Paul Weller’s 1980s Jam lyrics: Does the public get what the public wants or does the public want what the public gets?

An old dynamic reinvented

Radio used to be the main way in which audiences were essentially told what to listen to. Labels influenced what radios would play through a range of soft tactics – boozy lunches, listening sessions etc. – and hard tactics – pluggers, payola etc. Now radio is in long-term decline, losing its much-coveted younger audience to YouTube and audio streaming services. Streaming services have learned to capture much of this listening time by looking and feeling a lot more like radio through tactics such as curated playlists, stations, personalisation and podcasts. Curated listening is increasingly shaping streaming consumption, ensuring that the listening behaviours of streaming users resembles radio-like behaviour as much as it does user-led listening. The problem for the record labels is that they have less direct influence on streaming services’ playlists than they did on radio.

Chasing the data

All record labels have become far more data savvy over recent years, with the major labels in particular building out powerful data capabilities. This has resulted in a shift in emphasis from more strategic, insight-led data, such as audience segmentation, to more tactical, data such as streaming analytics.

At MIDiA we have worked with many organisations to help them improve their use of data and the number one problem we fix, is going to deep with analytics. It might sound like a crazy thing to say, but we have seen again and again, companies fetishize analytics, pushing out endless dashboards across the organisation. Too often the results are:

decision makers paradoxically pay less attention to data than previously, not more, because they assume someone else must be ‘on it’ because of all the dashboards

strategic decisions are made because of ‘blips’ in the data.

There is a danger that record labels are now following this path, relying too heavily on streaming analytics. It is interesting to contrast labels with TV companies. Until the rise of streaming, TV networks were obsessed with ‘overnight ratings’, looking at how a show performed the prior night. Now streaming has made the picture more nuanced, TV networks are turning to a diverse mix of metrics, incorporating ratings, streaming metrics, social data and TV show brand trackers. Streaming made the TV networks take a more diverse approach to data, but has made record labels pursue a narrower approach.

The risk for record labels is that doubling down on streaming analytics can easily result in double and fake positives and create the illusion of causality. Arguably the biggest problem is making curation-led trends look like user-led trends, mis-interpreting organic hits for manufactured ones.

Lean-back hits

One major label exec was recently telling me about how one of his label’s artists had ended up in Spotify Today’s Top Hits and racked up super-impressive stats. The success surprised the label as everything else they knew about the artists suggested it would not be such a big breakthrough performer. Nonetheless the label decided to rewrite its plan and threw a huge amount of marketing support behind the next single. Yes, you guessed it, it flopped. When the label went back to the streaming stats, it transpired that the vast majority of plays were passive. It was a hit because it was in a hit playlist that users tend not to skip through, which created an artificial hit, albeit a transitory one.

This case study highlights the two big challenges we face:

Streaming analytics stripped of the context of insight can mislead

Lean-back hits are not real hits

Chasing the stats

The two points are now combining to create what may yet be an A&R crisis. By chasing streaming metrics, the more commercially inclined record labels – which does not exclusively mean major labels – are creating a data feedback loop. By signing the genre of artists that they see doing best on playlists, they push more of that genre into the marketplace which in turn influences the playlists, which creates the double positive of that genre becoming even more pervasive. This sets off the whole process all over again. And because the labels are chasing the same genre of artists, bidding wars escalate and A&R budgets explode. This leads to labels having to commit even more money to marketing those genres because they can’t afford for their expensively acquired new artists not to succeed. All of this helps ensure that the music becomes even more pervasive. And so on, ad infinitum. Five years ago, this probably wouldn’t have been a problem but now record labels are flush with cash again, they are throwing out advances that they can now afford on a cash flow basis, but not on a margin basis. Because record labels – majors especially – remain obsessed with market share, none are willing to jump off the spinning wheel in case they jump too soon. It is a game of chicken. As one label exec put it to me: “In the old days we were betting on the gut instinct of an A+R guy who at least knew his music, now we’re chasing stats rather than tunes”.

Not so neutral platforms

Of course, none of this should be happening. Streaming platforms should be neutral arbiters of taste, simply connecting users with the music that best matches their tastes. But streaming services are locked in their own market share wars, each trying to add the most subscribers and drive the most impressive streaming stats – just look at how Spotify and Apple fell over each other to claim who had streamed Drake’s Scorpion most. In such an intense arms race, can any streaming service risk delivering a song to its users that might result in fewer streams than another one? Therefore, what we are now seeing is a subtle, but crucial, change in the way recommendation algorithms work. Instead of simply looking a user’s taste to estimate what other music she might like, the algorithms test the music on a sample of users to make sure they like it first before pushing it to a wider group of users that match that profile. In short, the algorithms are playing it safe with hits, which means surprise breakouts are becoming ever less likely to happen. Passenger’s slow burning ‘Let Her Go’ simply might never have broken through if it had been launched today. And yes, if you didn’t skip that Scorpion track in Today’s Top Hits then you are now that bit more of a Drake fan, even if you actually aren’t.

Where this all goes

Something needs to change, and ideally someone will have the balls to jump off the wheel before it stops spinning. Right now, we are on a path towards musical homogeneity where serendipitous discovery gets shoved to the side lines. And with listeners having progressively less say in what they like because they are too lazy to skip, record labels will become less and less able to determine whether they are getting value for money from their marketing and A&R spend.

Friday’s news that catalogue acquisition business Hipgnosis Songs Fund is set to float on the London Stock Exchange,having already raised around $260 million, reflects a booming market for music catalogues. However, the outlook for catalogue is not quite as straight forward as it at first appears. MIDiA Research has just published a major new report looking at the state of catalogue and its future: The Outlook for Music Catalogue: Streaming Changes Everything. This report was six months in the making and pulls data from a wide range of industry sources to provide a definitive view of the global catalogue market, both in terms of revenues and also mergers and acquisitions (M&A). The report is immediately available to MIDiA subscription clients and is also available for individual purchase on our report store here. Here follows a brief overview.

Album unbundling is now hitting catalogue

Music catalogue sales is fundamentally about nostalgia, enabling us to relive our younger years through rediscovering music that mattered to us. In the old sales model, record labels could release a greatest hits album every eight–10 years and convince consumers to pay for a dozen or more songs, when in reality they only ever wanted a handful of them. If you think about the artists that sound tracked your younger years but are not among your favourite artists, there are probably only around five songs that you can actually recall as liking. In the old sales model you would have listened most to those tracks on the full album, and even then, probablyonly a dozen or so times before lessening your listening. Now, with streaming, you can get straight to those five tracks, skipping the others, and probably still only listen to them a handful of times each, perhaps adding them to a playlist that you’ll listen to occasionally. The old model would have generated, say $5 gross revenue for the label. In the streaming model, five songs listened to ten times each would generate 28 cents for the label. It is the album unbundling dynamic all over again.

Younger audiences look forward, not back

Younger Millennials and Gen Z – those born between 1995–2014 – have more content pushed to them that is tailored specifically for them than at any other stage in history. This is digital’s baby boomer generation. They have never had it so good. With Instagram and Snapchat feeds perpetually filled with new content, they have little need or want to look back. The music industry isn’t helping things either with hundreds of thousands of tracks released every month, leaving little time for older music.

Even within streaming catalogue listening, the focus is very much on the new rather than the old. In the UK, according to the BPI, more than 70% of all catalogue (24-plus months old) streams are from on or after 2000. If we go back to the 1960s, where some of the most iconic catalogue artists were at their peak – e.g. the Beatles and the Rolling Stones – this decade accounted for just 3.6% of UK catalogue streams in [year]. In traditional catalogue valuations, the likes of the Beatles and the Stones will account for a major portion of valuations. In the streaming era, their value diminishes markedly.

Catalogue is caught between the two extremes of streaming and physical, with current revenue boosted by older CD and vinyl buyers coalescing around old favourites. These physical formats are often high-priced premium products and therefore create a skewed picture when comparing the consumption business of streaming to the sales model. Catalogue’s outlook is nuanced. Music catalogue generated $11.5 billion in retail revenues in 2017, which was up from 2016 and it will continue to grow through to 2025. Yet catalogue’s share of recorded music revenues will diminish.

Many strings to catalogue’s bow

Catalogue also looks different depending on where you sit in the value chain. If you are an influential indie label group like Beggars, you’ll see catalogue still performing strongly on streaming because you have the influential music that fans want to discover. Meanwhile, publishing catalogues are commanding large fees, not least Sony ATV’s $2.3 billion acquisition of 60% of EMI Music Publishing. Music publishing has felt the impact of streaming much more slowly than labels, but it is happening. Mechanical royalties from sales are plummeting, sync revenues are stable but a far larger volume of syncs are happening thus reducing average synch incomes. Meanwhile on streaming, publishers get a much smaller share of revenue than labels. And of course, streaming is killing off radio, another key publishing income source. So what labels are beginning to experience now, publishers will too.

The future needs rewriting

None of this means that catalogue is dead, but it does need an overhaul if it is to retain relevance. Selling people nostalgia is no longer enough on its own (though of course a solid market still exists for selling digital remasters to aging rock fans). The Guardians of the Galaxy is a great example of how to make catalogue work in the current market. For young fans of the movie, the music is simply the soundtrack to part of their culture that just happens to be decades old. The music is given new cultural context for a new generation. This is the sort of thinking catalogue needs to thrive in the streaming era.

A catalogue bubble

There is a risk that we are in a catalogue bubble. Acquisitions are on a rapid rise – check out the reportfor our year-by-year catalogue M&A activity – and will likely continue to rise over coming years, as illustrated by Hipgnosis, though given that the average transaction value for catalogues is $140 million the initial $260 million may not go that far.

The risk with the current market is that valuations are being built using the models that were shaped in the distribution era and that don’t properly reflect the dynamics of streaming. Also, there is a finite number of decent sized catalogues for sale, which means it is a sellers’ market, thus driving prices up further still.

With these dynamics and streaming’s emphasis on the new set to create a world of mega hits and audiences with less inclination towards looking back, catalogue is at a tipping point. Either it changes to meet the market or the market leaves it behind.

It was a day of two halves for YouTube. On one side a big press release went out championing a host of impressive new stats – including hitting 1.9 billion logged in users, following an official launch of YouTube Musicthe day before. Meanwhile, on the other side, the European parliament’s legal affairs committee voted in support of Article 13, whichwill overturn some basic premises of the fair use / safe harbour frameworks under which YouTube operates. The question is which half will prove to be most impactful on YouTube’s music strategy.

It’s complicated

If YouTube was to post the status of its relationship with the labels on its Facebook profile it would be ‘It’s complicated’. The whole value gap argument – which posits that YouTube does not pay as much as other streaming services because it does not have to directly license in the way they do – has created a war of words characterised by obfuscation and disinformation on both sides. Its super-recent new premium strategy was almost certainly timed to coincide with this vote and it helps present YouTube as a premium player, doing what the labels want.

But fundamentally, Google and its YouTube subsidiary are all about selling advertising. If you put too many of your most valuable customers behind an ad-free pay wall, advertisers will eventually stop paying as much for ads. Google is not about to kill off a large scale, high-margin business for a small scale, low margin one. In short, Google cannot afford for music subscriptions to be too successful.

The three numbers that matter

The EU vote will likely get pushed to a full parliamentary vote, so the legislative picture is still far from resolved. When determining the outcome, policy makers, YouTube and rights holders should consider three metrics: $0.0020, -51% and 171:

$0.0020: In the US, where there is a strong video ad market, effective per stream rates for YouTube actually increased by 14% in 2017 to $0.0020. Bet you haven’t heard that spoken about much by rights holders? Globally however, the rate fell for labels but, interestingly, was about flat for rights holders overall (publishers get paid on videos—such as cover versions, so there are more videos they get paid on, labels do not).What it means:YouTube’s US experience shows market economics can reduce the value gap.

–51%: This was Spotify’s gross margin on ad supported in Q1 2016. By Q1 2018 it had risen to 13%. This was in large part because the labels had cut Spotify better deals on ad supported, which meant that the difference between what YouTube pays and what Spotify pays now is smaller than it was in 2016 when the value gap lobbying was in full effect. What it means: the labels have reduced the value gap!

171: This is how many days it took on average for music videos to reach one billion views in 2017. In 2010 it took 1,841. YouTube has become far more effective at turning songs into hits, thus making it more valuable to the music business than ever before. Major record labels are in the business of making superstars, but superstars need massive global audiences to turn them into global brands—much bigger audiences than you get behind a Spotify paywall. The majors need YouTube’s scale to make global successes. What it means: the labels need YouTube as much as it needs them.

Commercial sustainability is the core issue

At the heart of the value gap argument is a fight for control. Rights holders want more control over YouTube to extract better deals and YouTube does not want to cede that control. But there is an argument that YouTube’s greater control enabled it to build a commercial sustainable model. Spotify, which does not have YouTube’s negotiating power, is still not generating a net profit on streaming. On a sliding scale, there are label-defined rates with a non-commercially sustainable business model at one end, while at the other end there is YouTube, which does not pay rights holders what they want, but has a commercially sustainable model. The solution clearly lies somewhere between the two extremes. Moreover, what is crucial, if YouTube is going to remain incentivised to continue to make music videos a success, is that rights payment need to be a share of revenue, not based on a minimum per track fee.

Would YouTube walk away from music?

Spotify is, for now at least, all about music, so it has to make it work. YouTube is not. If music suddenly becomes lower margin for YouTube with fixed per stream costs, then it would be commercially foolish for YouTube to do anything other than push its viewers to other forms of content than music. That 171-day metric didn’t happen on its own. YouTube honed its algorithms to ensure it can make hits faster for the music industry, but it can dial that back in an instant.

There is even a possibility that paying more for music rights could scupper YouTube’s entire business model as other types of rights holders might start demanding better rates too. The crux of the matter is that the current economics suit YouTube but not rights holders. What we have to be careful to avoid is a new paradigm where roles are reversed. As important as music is to YouTube, Google could walk away if it really wanted to. Rights holders—labels especially, need to think whether that is a price they are willing to pay.

The word on the street is that the deals labels have struck with Facebook for its forthcoming music service have been done on a blanket license basis (i.e. a flat fee) with no reporting. This was reported by Music Business Worldwideand has been confirmed to me by various well-placed third parties:

“One controversial element of these agreements is, we hear, that these are ‘blind’ checks: effectively, advances that are not tied to any kind of usage reports from Facebook.”

Now to be clear, this has not been confirmed by either the labels concerned nor by Facebook but, if true, it has potentially dramatic implications, and not where you would necessarily think.

Facebook will bring something highly differentiated to streaming

Facebook is obviously in legislative cross hairs right now because it has proven unable to keep sufficient tabs on user data. The reason reportedly given for the lack of reporting is that Facebook does not yet have the reporting technology in place to track and report on music consumption. Now, there is no doubt that music rights reporting is no small undertaking; it requires expensively constructed systems to manage complex frameworks of rights. Given that Facebook is likely to launch something that more closely resembles Musical.ly and Flipagram (e.g. sound tracking, messaging, social interaction and photo albums) than it does Spotify, the odds are that this proposition will be particularly complex from a reporting perspective. But, and it is a crucial ‘but’, this challenge of tracking, enforcing and reporting on music-integrated user-generated content (UGC) is exactly the same challenge YouTube has been grappling with for years.

Facebook will become the new big player in UGC music

As we all know, YouTube’s relationship with music rights holders (labels in particular) has been fraught with conflict, tension and disagreement. The recorded music industry remains committed to rolling back much of the ‘fair use’ rules under which YouTube operates, to ensure that it can be licensed more like the standard music services. And it appears that genuine legislative progress has been made with big announcements mooted for later this year.

However, if I was part of YouTube’s lobbying team right now I’d be thinking I’ve just been given a free pass. The crux of the industry’s argument is that YouTube does not sufficiently protect copyright, enforce policing nor pay enough. Not paying enough is not directly a legislative issue, but instead a commercial factor. But the labels argue that the unique ‘fair use’ basis on which YouTube operates enables is to pay too little.

If the assumed basic premise of this deal is indeed correct, it transforms in an instant, YouTube from wild west desperado into the closest thing global scale UGC music has to a sheriff. YouTube’s Content ID system is more than 99% accurate at tracking and reporting on consumption. There is so much music on YouTube because in large part the labels need YouTube as a marketing platform. In fact, labels spend more on YouTube marketing than any other digital channel except social.

Fair use lobby efforts may be impacted

Meanwhile Facebook’s position on reporting, according to Music Business Worldwide, is:

“the social media service has committed to building a system which will be able to provide such usage reports – and therefore royalty reports – in the future.”

The deal as a whole could result in three potential legislative outcomes:

Proposed regulations are rethought

Proposed regulations are put on ice

Proposed regulations are implemented but applied equally to Facebook too

The latter is a possibility, but the complication is that the labels – and again this is if the suggested deal structure is correct – have chosen to enable Facebook to behave in many of the exact ways which they do not want YouTube to operate.

Of course, there are good reasons this deal has happened, not least that Facebook will make a massive contribution to the digital music space in a truly different way. But perhaps more importantly in this context, Facebook will have paid enough to make the labels do a 180 degree turn on their approach to UGC. Therein lies the heart of the YouTube problem. Rights holders want to get paid more, and lobbying for legislative change is seen as the only way to make that happen. But some of the fundamentals that underpin that change are potentially put into question by the Facebook deals. So, there is a chance that in their efforts to get more revenue from Facebook, the labels might just have compromised their ability to get even more revenue in the long term from YouTube.

Streaming has driven such a revenue renaissance within the major record labels that the financial markets are now falling over themselves to work out where they can invest in the market, and indeed whether they should. For large financial institutions, there are not many companies that are big enough to be worth investing in. Vivendi is pretty much it. Some have positions in Sony, but as the music division is a smaller part of Sony’s overall business than it is for Vivendi, a position in Sony is only an indirect position in the music business.

The other bet of course is Spotify. With demand exceeding supply these look like good times to be on the sell side of music stocks, though it is worth noting that some hedge funds are also exploring betting against both Vivendi and Spotify. Nonetheless, the likely outcome is that there will be a flurry of activity around big music company stocks, with streaming as the fuel in the engine. With this in mind it is worth contextualizing where streaming is right now and where it fits within the longer term evolution of the market.

The evolution of paid streaming can be segmented into three key phases:

Market Entry: This is when streaming was getting going and desktop is still a big part of the streaming experience. Only a small minority of users paid and those that did were tech savvy, music aficionados. As such they skewed young-ish male and very much towards music super fans. These were people who liked to dive deep into music discovery, investing time and effort to search out cool new music, and whose tastes typically skewed towards indie artists. It meant that both indie artists and back catalogue over indexed in the early days of streaming. Because so many of these early adopters had previously been high spending music buyers, streaming revenue growth being smaller than the decline of legacy formats emerged as the dominant trend. $40 a month consumers were becoming $9.99 a month consumers.

Surge: This is the ongoing and present phase. This is the inflection point on the s-curve, where more numerous early followers adopt. The rapid revenue and subscriber growth will continue for the remainder of 2017 and much of 2018. The demographics are shifting, with gender distribution roughly even, but there is a very strong focus on 25-35 year olds who value paid streaming for the ability to listen to music on their phone whenever and wherever they are. Curation and playlists have become more important in order to help serve the needs of these more mainstream users—still strong music fans— but not quite the train spotter obsessives that drive phase one. A growing number of these users are increasing their monthly spend up to $9.99, helping ensure streaming drives market level growth.

Maturation: As with all technology trends, the phases overlap. We are already part way into phase three: the maturing of the market. With saturation among the 25-35 year-old music super fans on the horizon in many western markets, the next wave of adoption will be driven by widening out the base either side of the 25-35 year-old heartland. This means converting the fast growing adoption among Gen Z with new products such as unbundled playlists. At the other end of the age equation, it means converting older consumers— audiences for whom listening to music on the go on smartphones is only part (or even none) of their music listening behaviour. Car technologies such as interactive dashboards and home technologies such as Amazon’s echo will be key to unlocking these consumers. Lean back experiences will become even more important than they are now with voice and AI (personalizing with context of time, place and personal habits) becoming key.

It has been a great 18 months for streaming and strong growth lies ahead in the near term that will require little more effort than ‘more of the same’. But beyond that, for western markets, new, more nuanced approaches will be required. In some markets such as Sweden, where more than 90% of the paid opportunity has already been tapped, we need this phase three approach right now. Alongside all this, many emerging markets are only just edging towards phase 2. What is crucial for rights holders and streaming services alike is not to slacken on the necessary western market innovation if growth from emerging markets starts delivering major scale. Simplicity of product offering got us to where we are but a more sophisticated approach is needed for the next era of paid streaming.

NOTE: I’m going on summer vacation so this will be the last post from me for a couple of weeks.

Today the IFPI published their annual assessment of the global recorded music business. The key theme is the first serious year of growth since Napster kicked off a decade and a half of decline, with streaming doing all the revenue heavy lifting.

The findings won’t come as much of a surprise to regular readers of this blog, as at MIDiA we had already conducted our own market sizing earlier in the year. The IFPI reported just under a billion dollars of revenue growth in 2016 (we peg growth at $1.1 billion) with streaming driving all the growth (60% growth, we estimate 57%). IFPI also reported 112 million paying subscribers (our number is 106.3 million, but the IFPI numbers probably include the Tencent 10 million number as reported, while the actual number is closer to 5 million).

IFPI report physical sales declining by 8% (we have 7%) and downloads down by 21% which is 3 percentage points more decline than the majors reported; this implies the IFPI estimates the indies to have had a much more pronounced decline than the majors. MIDiA is currently working with WIN to create the 2017 update to the global indie market sizing study, so we’ll be able to confirm that trend one way or another in a couple of months’ time.

Overall, the IFPI numbers tell the same good news story we revealed back in February, namely that streaming is finally driving the format replacement cycle that the recorded music business has not had since the heyday of the CD. Without streaming, the recorded music market would have declined in 2016. Streaming is driving revenue growth by both growing the base of users and, crucially, increasing the spend of more casual music spenders, changing them from lower spending download buyers into monthly 9.99 customers.

Also, streaming is unlocking spending in emerging markets (especially Latin America). The old model was based on people being able to afford a CD player and being able to afford to buy albums. The new model monetizes consumption on smartphones (which are becoming ubiquitous in emerging markets). Expect each year from now to see a reallocation of recorded music revenue towards emerging markets. It will be a long process but an irresistible one. Indeed, as Spotify’s Will Page put it:

“Spotify’s success story has expanded beyond established markets, with Brazil and Mexico now making up two of our top four countries worldwide by reach. Back when the industry peaked in 2000, Brazil and Mexico were 7th and 8th biggest markets in the world respectively.A combination of increasing smartphone adoption [reaching far more users than CDs ever did] and Spotify’s success makes the potential for these emerging markets to ‘re-emerge’ and to exceed previous peaks.”

One surprising point is that the IFPI reported a total of $4.5 billion for streaming ($3.9 for freemium and $0.6 billion for YouTube, etc.). However, the major labels alone reported revenues of $3.9 billion (see my previous post for more detail on label revenues). That would give the majors an implied market share of 87% in streaming. Which seems like a big share even accounting for majors including the reveue of the indie labels they distribute in their revenue numbers (eg Orchard distributed indie label revenue appearing in Sony’s numbers). Last year the IFPI appeared to have put Pandora revenues into US performance revenues rather than treat them as ad supported streaming, so that could account for an extra $400 million or so.

Nonetheless, taking the IFPI’s $3.9 billion freemium revenue and the 112 million subs number both at face value for a moment, that would equate to an average monthly label income of $2.90 per subscriber or a combined average monthly income of $1.53 for total freemium users (including free). These numbers are skewed in that they are year end numbers (mid year user numbers would be lower, so ARPU would be higher) but they are still directionally instructive ie there is a big gap between headline 9.99 pricing and what label revenue is actually generated due to factors such as $1 for 3 month trials and telco bundles.

All in all, a great year for recorded music. And despite a slow-ish Q1 2017 for streaming and the impending CD revenue collapse in Japan and Germany, it looks set to be another strong year ahead for streaming and, to a lesser extent, the broader recorded music business.

One of the themes my MIDiA colleague Tim Mulligan (the name’s no coincidence, he’s my brother too!) has been developing over in our online video research is that of next generation TV operators. With the traditional pay-TV model buckling under the pressure of countless streaming subscriptions services like Netflix (there are more than 50 services in the US alone) pay-TV companies have responded with countless apps of their own such as HBO Go and CBS All Access. The result for the consumer is utter confusion with a bewildering choice of apps needed to get all the good shows and sports. This creates an opportunity for the G.A.A.F. (Google, Apple, Amazon, Facebook) to stitch all these apps together and in doing so become next generation TV operators. Though the G.A.A.F. are a major force in music too, the situation is also very different. Nonetheless there is an opportunity for companies such as these to create a joined up music experience that delivers an end-to-end platform for artists and music fans alike. Right now, Spotify is best placed to fulfil this role and in doing so it could become a next generation “label”. I added the quote marks around the word “label” because the term is becoming progressively less useful, but it at least helps people contextualise the concept.

Creating The Right Wall Street Narrative

When news emerged that Spotify was in negotiations to buy Soundcloud I highlighted a number of potential benefits and risks. One thing I didn’t explore was how useful Soundcloud could be in helping Spotify build out its role as a music platform (more on that below). As I have noted before, as Spotify progresses towards an IPO it needs to construct a series of convincing narratives for Wall Street. The investor community generally looks upon the music business with, at best, extreme caution, and at worst, disdain. To put it simply, they don’t like the look of low-to-negative margin businesses that have little control over their own destinies and that are trying to sell a product that most people don’t want to buy. This is why Spotify needs to demonstrate to potential investors that it is working towards a future in which it has more control, and a path to profitability. The major label dominated, 17% gross operating margin (and –9% loss) 9.99 AYCE model does not tick any of those boxes. Spotify is not going to change any of those fundamentals significantly before it IPOs, but it can demonstrate it is working to change things.

The Role Of Labels Is As Important As Ever

At the moment Spotify is a retail channel with bells and whistles. But it is acquiring so much user data and music programming expertise that it be so much more than that. The role of record labels is always going to be needed, even if the current model is struggling to keep up. The things that record labels do best is:

Discover, invest in and nurture talent

Market artists

Someone is always going to play that role, and while the distribution platforms such as Spotify could, in theory at least, play that role in a wider sense, existing labels (big and small) are going to remain at the centre of the equation for the meaningful future. Although some will most likely fall by the wayside or sell up over the next few years. (Sony’s acquisition of Ministry Of Sound is an early move rather than an exception.) But what Spotify can do that incumbent labels cannot, is understand the artist and music fan story right from discovery through to consumption. More than that, it can help shape both of those in a way labels on their own cannot. Until not so recently Spotify found itself under continual criticism from artists and songwriters. Although this has not disappeared entirely it is becoming less prevalent as a) creators see progressively bigger cheques, and b) more new artists start their career in the streaming era and learn how to make careers work within it, often seeing streaming services more as audience acquisition tools rather than revenue generators.

The Balance Of Power Is Shifting Away From Recorded Music

In 2000 record music represented 60% of the entire music industry, now it is less than 30%. Live is the part that has gained most, and the streaming era artist viewpoint is best encapsulated by Ed Sheeran who cites Spotify as a key driver for his successful live career, saying “[Spotify] helps me do what I want to do.” Spotify’s opportunity is to go the next step, and empower artists with the tools and connections to build all of the parts of their career from Spotify. This is what a next generation “label” will be, a platform that combines data, discovery, promotion (and revenue) with tools to help artists with live, merchandise and other parts of their career.

How Spotify Can Buy Its Way To Platform Success

To jump start its shift towards being a next-generation “label” Spotify could use its current debt raise – and post-IPO, its stock – to buy companies that it can plug into its platform. In some respects, this is the full stack music concept that Access Industries, Liberty Global and Pandora have been pursuing. Here are a few companies that could help Spotify on this path:

Soundcloud: arguably the biggest artist-to-fan platform on the planet, Soundcloud could form a talent discovery function for Spotify. Spotify could use its Echo Nest intelligence to identify which acts are most likely to break through and use its curated playlists to break them on Spotify. Also artist platforms like BandPage and BandLab could play a similar role.

Indie labels: Many indie labels will struggle with cash flow due to streaming replacing sales, which means many will be looking to sell. My money is on Spotify buying a number of decent sized indies. This will demonstrate its ability to extend its value chain footprint, and therefore margins (which is important for Wall Street). It could also ‘do a Netflix’ and use its algorithms to ensure that its owned-repertoire over performs, which helps margins even further. But more importantly, indie labels would give Spotify a vehicle for building the careers of artists discovered on Soundcloud. Also the A&R assets would be a crucial complement to its algorithms.

Tidal: Spotify could buy Tidal, taking advantage of Apple’s position of waiting until Tidal is effectively a distressed asset before it swoops. Though Tidal is most likely to want too much money, its roster of exclusives and its artist-centric ethos would be a valuable part of an artist-first platform strategy for Spotify.

Songkick: In reality Songkick is going to form part of Access’ Deezer focused full stack play. But a data-led, live music focused company (especially if ticketing and booking can play a role) would be central to Spotify driving higher margin revenues and being able to offer a 360 degree proposition to artists.

Pandora: A long shot perhaps, but Pandora would be a shortcut to full stack, having already acquired Ticket Fly, Next Big Sound and Rdio. If Pandora’s stock continues to tank (the last few days of recovery notwithstanding) then who knows.

In conclusion, Spotify’s future is going to be much more than being the future of music retail. With or without any of the above acquisitions, expect Spotify to lay the foundations for a bold platform strategy that has the potential to change the face of the recorded music business as we know it.

Leading UK indie Ministry of Sound Recordings today announced its sale to Sony Music UK. While this is undoubtedly another case of a big major swallowing up a smaller indie, there is a much more important angle to this – surviving in the streaming era. Ministry of Sound is unusual in that it is a label with a relatively small catalogue, instead its business is built around compilations. In doing so it has built an incredibly robust and profitable business. No mean feat in the current climate. But Ministry’s core strength has also become an Achilles Heel with the onset of streaming.

Ministry licenses music from other labels to build its compilations. This approach works well in a sales model where proceeds are split between the respective parties. But in the context of streaming, any money generated by plays of tracks on a compilation go to the label that owns the track not to the label that curated the compilation. This is why Ministry compilations have been conspicuously absent from streaming services and it is also why Ministry ended up in conflict with Spotify when the streaming service initially refused to take down user playlists that replicated Ministry compilations and that used Ministry artwork.

With its co-owned Now brand, Sony is as good a fit as Ministry could find in a major. Sony for their part are getting one the most valuable compilation brands and immediate dance music culture credibility. Sony also has big digital plans for Now, which Ministry will no doubt slot into nicely. On top of this, because Sony own so much catalogue themselves, they can make the economics of compilations work in the streaming environment.

The fact that 25% of music subscribers still buy compilation albums show that however a good job streaming playlists might be doing, there remains a big demand for compilations, even within the core of streaming music aficionados. Curated playlists will continue to gain importance but compilations are going to live alongside them for a good long time to come. And all the while the distinction between what constitutes a playlist and a compilation will continue to blur.

Tuesday’s media scrum around Spotify’s financials illustrate that whatever ground Apple and Tidal may have made in recent months, Spotify clearly remains the poster child / bellwether for streaming. The stories oscillated between the broken nature of the underlying economics to how streaming is the future of the music business. Both are true. But a closer look at the numbers reveal some even more important findings.

Rights costs are Spotify’s Achilles Heel. Rights and associated costs accounted for 83% of Spotify’s 2015 revenue, up from 81% in 2014 and this resulted in a dramatic fall in Spotify’s gross margin per user: down from $4.20 in 2013 to $3.45 in 2015. This is particularly challenging for a model with already wafer thin margins. A number of factors underpin this decline:

Discounted promotions: Promos such as the £0.99 for 3 months have supercharged Spotify’s growth for the last 18 months. But as labels only contribute part of the cost this means that Spotify loses more margin with every new promo user

Advanced label payments: When Spotify strikes its licensing deals with labels it makes advanced payments and guarantees based on its expected growth. This means that for a growth stage company like Spotify, booked rights costs will always be higher than current booked revenue. This has obvious cash flow implications. Also, should Spotify’s growth slow and it miss those targets, it will still have to pay the monies guaranteed to labels, at which point the rights costs share will rise even further

Publisher rates: Over the last couple of years, music publishers have been asserting their role in the digital music value chain, pushing for more equitable rates. The net result is that publishing rights costs can now range up to 15%, depending on the deal, up from a low of 10% in some cases. This upward momentum will continue, and as labels aren’t decreasing their rates, it means less margin for Spotify and other streaming services

As Spotify edges towards an IPO it is doing everything within its power to get its house in order. It is investing in video to show Wall Street it is attempting to lessen its dependence on the labels and it is improving is cost ratios virtually everywhere else in its business, other than rights. Between 2013 and 2015, the Average Cost Per User (ACPU) for Research and Development fell from $2.12 to $1.61 and for Marketing it fell from $3.23 to $2.77. But Rights ACPU grew from $17.59 to $18.35. In fact, even in terms of costs as a % of revenues, every single expense Spotify reported fell except Rights (and Depreciation and Amortization which increased slightly). It is rising rights costs that are keeping Spotify from commercial sustainability.

There is another really important part of Spotify’s growth story: subscriber ARPU has fallen from $79.09 in 2013 to $62.30 in 2015. This is a result of multiple efforts to drive growth, including the price promos, telco bundles and student discounts. All of which are viable tactics but the fact they are necessary to drive Spotify’s growth underscore a point I have been making for years: 9.99 is not a mass market price point, and Spotify’s subscribers agree. By transforming the ARPU into an effective monthly retail price, Spotify’s average price point is now just $6.49, down from $8.24. It is about time that the music industry stopped pretending that this isn’t the reality of the market and instead starts pursuing proper pricing innovation rather than by stealth via discounting, which only serves to confuse consumers about long term value.

The music industry is in a transition phase. In such periods, the old and new worlds co-exist and collide. There are statistics that both sides of any argument can hold up in their defence, in fact they can often hold up the very same numbers to support opposite perspectives. Similarly, the comparisons you chose to benchmark with, can paint entirely different pictures. Such is the nature of transitions of human and business behaviour. For example, 83% of Spotify’s gross revenue going to rights is clearly too high and unsustainable, yet $0.00098 per song going to artists is also clearly too low and unsustainable. Something needs to give, for both ends of the value chain.

Maybe if/when Spotify gets to 50 million subscribers it will feel it has enough clout to compel rights holders to rethink licensing economics. Perhaps it will take Spotify getting to a 100 million to make that happen. Perhaps it will never happen. But if it doesn’t, the economics of streaming will remain so broken that only companies with ulterior business objectives will remain viable players, enter stage left streaming’s Triple A: Apple, Amazon and Alphabet (Google). The labels need to ask themselves whether that is the streaming future they want…

Later this week we’ll be publish a new report in the MIDiA Research Music report and data service: ‘After The Album: How Playlists Are Re-Defining Listening’. In it we explore the changing role of streaming playlists and in particular how they are impact albums both as a consumption format and as a revenue model. The full 18 page report includes half a dozen graphics and a couple of sheets of excel, including a detailed revenue model. I want to share with you here one of the key themes we explore in the report…

Playlists Are The Lingua Franca Of Streaming

Streaming hit a host of milestones in 2015, reaching 67.5 million subscribers and driving $2.9 billion of trade revenue, up 31% on 2014. While the competitive marketplace upped the ante, music services wielded curation to drive differentiation. Playlists have always been the core currency of streaming, but now more than ever they are becoming the beating heart, the fuel which drives both discovery and consumption. In doing so they are helping drive hit singles into the ascendancy and albums to the side lines.

The Album Is No Longer TheMarket

Perhaps the biggest problem with streaming’s dissolution of the album is that the wider industry is still catching up with the concept. Artists still consider the album as their core creative construct, their novel. Similarly, labels still build P&Ls, marketing campaigns and their core business models around albums and album release schedules. There will long remain a market for albums, especially among core fan bases, as TIDAL’s exclusive album campaigns for Kanye West and Beyoncé reveal. But it is just that: a market, not the market anymore.

Income Per Streaming User

The most effective way to measure the value of streaming is to measure the value per user. For record labels at a macro level this equated to $2.80 annual revenue per subscriber and $0.37 per free streamer globally in 2015. But even that measure is too blunt to allow label campaign teams, artists and their managers to understand the value to them because that value is wrapped up with all the music in the world. For these stakeholders a more meaningful measure is the average amount they earn per album per streaming user.

Income Per Album Per Streaming User

Music subscribers in the US and UK streamed an average of 3,447 streams each in 2015, averaging 66 streams a week. But the average number of complete unique albums streamed was just 47 for the whole year. The average across free and paid streaming users was 11. Less than one new album per year. In the old model that average would have been just fine, pulling in more than $100 in retail revenue per user but in the streaming model that equate to a combined total of $0.73 in rights holder revenue.

Even that measure though, is only partially useful for an artist, manager, songwriter or label campaign manager. What matters for them is how much they earn per streaming user, not the music industry in general. The average royalty income per album per streaming user is $0.21, with $0.03 flowing to the artist and $0.02 flowing to the songwriter. For subscribers the average income is $0.44 with $0.05 flowing to the artist and $0.04 flowing to the songwriter. While for free users it is $0.13 and $0.01 for artists and $0.01 for songwriters.

What It All Means

Albums are not the currency of streaming. Everyone needs to rethink what long form, artist led content consumption looks like on streaming. Music fans still want artist led experiences. Drake’s 46 million Spotify listeners is more than double all the Filtr, Digster, Topsify and Todays’ Top Hits followers put together. As I have suggested before, multimedia artist subscription bundles for $1.50 on top of standard streaming fees feel like the right fit and would also help start pushing up streaming ARPU.

The power of music discovery used to lie in the hands of the radio DJ, now it lies in the hands of the playlist curator. And because streaming has melded discovery and consumption into a single whole, that means their power is becoming absolute. Albums are not quite an afterthought in the curated playlist world, but they are certainly an awkward relative that doesn’t quite fit in at the party.

None of this to say that the album is dead, but it can no longer be considered the main way most people listen to music. Of course some would argue that with radio it has ever been thus…

To find out more about the report and how to access MIDiA reports and data either visit our website or email us on info AT midiaresearch DOT COM